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Tuesday, December 11, 2012

Marco Rubio, the GOP, and NGDP Level Targeting

One of the hardest points to make to my fellow conservatives is that Fed policy actually has not been easy over the past four years. Yes, monetary policy has been ad-hoc, unpredictable, and appears to have been hyperactive with its large-scale asset purchases. Despite these actions, the Fed has failed to reduce the elevated demand for liquid assets. This is evident in the seemingly insatiable appetite for treasuries that is keeping yields at historic lows and in the latest Flow of Funds data that shows households are still holding an inordinate share of liquid assets in their portfolios.1 As Bernanke notes, though, the Fed is actually capable of addressing this problem in a systematic, rule-based fashion but has failed to do so. This failure amounts to a passive tightening of monetary policy.

One reason for this failure is the political pressure the GOP has placed on the Fed. Most in the GOP think the Fed has been too easy and want it to do less. Specifically, many in the GOP want to narrow the Fed's mandate to just inflation targeting. Senator Marco Rubio is the latest to push this view. Matt O'brien agrees with Rubio that the Fed's mandate needs to be narrowed, but in a different way:

But Rubio is right that the Fed needs a better, clearer monetary rule nowadays... Imagine the
Fed had a single mandate, but not for inflation. Imagine instead the
Fed had a single mandate for the total size of the economy, which goes
by the unwieldy name of nominal GDP (NGDP). During the Great Moderation,
NGDP grew about 5 percent a year, but it's only grown about 2.85 percent a year since 2008.
If the Fed had an NGDP target of 5 percent a year, and was supposed to
make up for any over-or-undershooting, it would have been aggressively
easing the entire time since 2008. It's a dual mandate that doesn't get
confused by low inflation and low growth.

O'brien is correct that a NGDP level target is a superior way to narrow the Fed's mandate. Unlike an inflation target, it is not susceptible to misinterpreting supply shocks and systematically accounts for past policy mistakes. NGDP level targeting also increases the transparency of the Fed, makes its actions more predictable, and reduces the need for countercyclical fiscal policy. It is a GOP dream. Republicans should be out in front of this idea, promoting it vigorously. They could start by reading this paper.

1Don't even think of blaming the Fed for the low yields on treasury yields.

I studied chemistry in college, and I only took intro (micro) economics. I'm still trying to learn more about economics in general, so not surprisingly, I am confused about the significance of Matt O'Brien's 2.85% NGDP post-2008 average growth quote. Mainly, I do not understand how NGDP growth needs to be a subject of concern when, as you noted in the last post, year-over-year aggregate NGDP growth is currently stable at 4.5%.

I agree with you that NGDP targeting is a good idea, in my understanding of it, as it would be a much clearer goal than current policy, with outcomes that are easy to track. So given that the Fed is stabilizing NGDP growth so well, we should absolutely solidify their work by making NGDP-level targeting a mandate and focus, as you argue. But is whether or not we mandate policies a cause for concern? In practical terms, does a mandate for NGDP-level targeting dramatically improve our current approach to fixing the economy?

Doug,Obrien's concern is with returning NGDP to a pre-crisis trend. This is important because many households and firms took out long-term debt prior to the crisis with the expectation that nominal incomes (reflecting NGDP growth) would continue to grow at 5%. That hasn't happened and debt burdens are consequently higher than expected. Returning to pre-crisis trend growth would correct that.

With that said, we could still adopt a NGDP level target without doing such catch up growth as you note. Here, though we would still need an explicit target to make it truly effective.

See this post for more on the level issue: http://macromarketmusings.blogspot.com/2012/09/john-cochrane-michael-woodford-and.html

Benjamin, agreed. It's funny (actually, not funny at all, quite sad) to hear modern support for Ulysses S. Grant vetoing the Republican-initiated "Inflation Bill" of 1874. Apparently we need a 5 year long depression.

Market monetarism needs a trade association that can educate GOP Congressional staffers about M policy. 99% of GOPers on the Hill believe that Bernankeism represents a left-wing threat to real prosperity. There is no one out there to tell them otherwise.